Bank accounts serve as a tool for personal and private finances. In the past, bank accounts were not typically investigated or monitored by the Internal Revenue Service (IRS) unless a taxpayer experienced an audit. However, following a proposal by the Biden Administration, IRS can now look into your bank account.
Watch our full video below for a detailed explanation of why IRS wants to look into bank accounts.
Read on to learn why IRS wants to look into your account, what information they’re looking for, and how this financial reporting will work.
Why Does IRS Want to Look into Your Bank Account?
IRS’ goal is to find account holders who use personal checking accounts to avoid paying full tax amounts and narrow the tax gap.
What is the Tax Gap?
The tax gap is the difference between taxes owed and taxes collected. According to the U.S. Department of Treasury, the tax gap amounts to approximately $600 billion annually and has exceeded $7 trillion in unpaid taxes over the last decade. The U.S. Department of Treasury also claims the wealthiest one percent of Americans alone evade over $163 billion in taxes each year.
How Will This Financial Reporting Work?
According to the U.S. Treasury, banks and financial institutions will include “just two additional numbers to the information that they already supply to taxpayers and the IRS.”
What Information Will IRS Look At?
The “two additional numbers” IRS is asking banks and institutions to report are:
- The total amount of funds deposited into the account over the course of the year
- The total amount of funds withdrawn from the account over the course of the year
How Will IRS Use This Financial Information?
IRS will compare the annual tax flow of account holders against their tax returns to determine if the account holder is likely paying the full amount of taxes or if the account holder should be audited.
What Other Financial Information Will IRS Look at?
The Treasury claims “the scope of this information sharing is extremely limited.” Further, the Treasury reiterates that banks will not share individual spending or transactions, nor will IRS have the ability to track such transactions.
In short, no individual spending information will reviewed–only the total sum of deposits and withdrawals.
What Other Information Does IRS Already Have Access To?
The IRS obtains information on taxpayers from sources such as:
- Filed tax returns
- Third parties, such as the Social Security Administration
- Information statements about the taxpayer under their Social Security number, such as W-2 forms and Form 1099
From this information, IRS likely already knew about each taxpayer’s accounts, but will now know what funds are going in and out of those same accounts as well.
What Are the Risks of IRS Looking into Bank Accounts?
IRS looking into personal checking accounts can lead to additional and unnecessary audits as well as violate bankers’ privacy. There are multiple explanations for why money coming into your bank account–whether business or personal–is not income.
How Can IRS Looking into Bank Accounts Affect Small Business Owners?
Banks reporting deposits and withdrawals to IRS may lead to additional audits for small business owners (SBOs)–even if the SBOs are paying their taxes fully and correctly.
For example, a small business owner may deposit $1,000,000 into their bank account but only report $600,000 of income. The bank will report the $1,000,000, exposing the difference between the original deposit and the amount the SBO reported; this difference could potentially lead to an IRS audit as the IRS will want more information on the unreported income. More specifically, IRS will want to know if the SBO should be paying taxes on the $400,000.
However, there are several reasons that an SBO may deposit income and not report the full deposit amount, such as:
- There may be non-income items deposited into the account.
- The SBO might have taken money from a credit line, a loan, or transferred money between accounts.
How Is This Financial Reporting Different Than IRS Audits?
During our client’s audit processes, our office performs a bank deposit analysis. We’ll add up the total deposits for the year, review the total cash flow, and compare that to the tax return. If these two figures are off, we’ll meet with the client to discuss the discrepancies and ask them to justify whether each deposit is or is not income.
In an audit, IRS will conduct a similar analysis.
However, the difference is that IRS only had access to this information in an audit instead of on a day-to-day level. IRS shouldn’t have access to the banking information of all Americans with accounts in the United States; it is an unnecessary invasion of privacy.
Do you know what to do if your business’ tax return was flagged for an audit by IRS? Learn more here.